Courtesy AP

Moody’s reacted strongly to a move by the NAIC that could increase regulatory reserves on universal  life insurance with secondary guarantees (USLG) by saying that it could have a negative impact on credit for U.S. insurers if applied retroactively, and even hurt the bottom line of insurers if applied just to future business.

Applying the reserve methodology retroactively is a credit negative “because a number of companies could be forced to immediately add significant reserves, disrupting operations and constraining their capital position and business operations,” the Moody’s report, written by Ann G. Perry, a Moody’s senior credit officer.

Moreover, the additional reserve requirement could lead markets for these reserve financing alternatives  to be overwhelmed if multiple companies sought to offload a large volume of reserves at the same time, leading to higher prices, Perry wrote.

The NAIC moved Nov. 4 to establish a new task force to come up with an interim solution on reserving on USLG products after a firestorm around the Actuarial Guideline 38, and if loopholes were being exploited to the detriment of companies’ reserves. It may be applied to policies in force retroactively, or just ones written in the future. The group is expected to develop something by the March national meeting, regulators sad at the fall meeting.

Some of those reserves could be significantly increased, Moody’s determined.

 “We typically view higher reserves as credit positive because they provide policyholders and creditors with a greater cushion against unfavorable performance.,” Perry wrote, but then said the retroactive application would have the reverse effect. 

And even if reserves are just applied to future business, this would still lead to the “reduced ability of life insurers to absorb the surplus strain from writing business at higher reserve levels would necessitate price increases,” leading to lower sales, hurting profitability and internal capital generation, Perry stated. 

Perry also added that the additional reserves “probably won’t meaningfully further protect policyholders and creditors because…there is no assurance that the extra reserve cushion would actually remain in the companies.”

Perry sees them going, instead, to captive reinsurers.

“ …our expectation is that many companies would finance these ‘non-economic’ reserves by reinsuring them to captive reinsurers rather than strengthen their capital position to build higher reserves.”

This could also cost, Perry stated: “Captive reinsurers are owned by the group and although risks appear to be transferred, they typically remain in the enterprise. Third-party reinsurance is more likely to entail true risk transfer, but market capacity is already limited and the cost is usually higher.”

Adequate reserves are not the issue for the public, Perry suggested. 

Insurers generally need to demonstrate each year that their reserves, including reserves on policies affected by this reserving issue, meet a prescribed asset adequacy test, Perry noted. The tests assure regulators that companies are adequately reserved.”

Regulatory intervention could also create a scenario in which companies would need to allocate potentially substantial amounts of capital to support at least a portion of the additional reserve burden. Then state insurance regulators would be incentivized to grant a waiver, essentially allowing insurers a pass on booking the added reserves, if regulatory capital were suddenly constrained, Perry wrote.